The concept of inflation eludes me. I understand that it causes prices to rise, and is often said to be "too many dollars chasing too few goods". But I can't seem to wrap my head around it...

Could inflaction be represented by the following equations:Value of the dollar = money supply/ goods and servicesInflation = V$ in year X - V$ in year 0

If so, does this mean that if the money supply were to increase, inflation would go up, unless more goods and/or services were offered?Conversely, if more goods and services were offered, with no change in the money supply, there would be deflation?

So, stimulus spending (i.e. increased money supply) causes inflation, unless the effect of the money encouraged new businesses offering goods and/or services.And, in a recession, when goods and services go away due to businesses going under, this is why there is inflation.

At 3/2/2013 1:37:03 PM, ZakYoungTheLibertarian wrote:Stimulus spending only increases the money supply if it's financed by deficits. If it's financed by taxes directly there's no inflation because the money supply hasn't increased.

It's supply and demand. If the supply is increased, and the demand stays the same, the price goes down. You can think of prices not only of goods, but also the price of money in terms of goods.

I understand supply and demand, but in your explanation, what is the supply and what is the demand? If money is the supply, is that not inflation, while demand for goods is constant. This sounds contradictory to the axiom: too many dollars chasing too few goods.

Are you saying that inflation is just the aggregate of supply and demand effects on prices? If so, why does money supply affect the price?

The definition of inflation is simply an increase in the general price level, and therefore a fall in the purchasing power of money. If your tube of toothpaste previously cost $2 and now costs $5, each dollar now buys less of the same amount of toothpaste. Inflation occurs for a variety of reasons. Econ 101 focuses on a couple key models.

First, what you said about "too many dollars purchasing too few goods" is called demand-pull inflation. When the supply of good X stays the same, but suddenly a bunch more people decide to buy good X than usual, there will be a "bidding war" as people try to get their hands on X, and the price of X will increase. This can occur on a general scale as economies take off or the money supply increases. More people have more dollars to spend, so the price of goods are bidded up.

Another type of inflation is called "cost push inflation." This is when the demand for goods stays the same, but the supply DECREASES. In the 1970s during the Arab Oil Embargo, global oil supplies tightly contracted at the market. People still needed oil for there cars and homes, so there was a bidding war for what was left. The price of gasoline increased sharply as there simply wasn't enough to go around. Because oil is so fundamental to almost every product on the market, the general price level increased. Ergo, inflation.

Of these two types of inflation, demand-pull is generally considered "less bad." Why? Because when there are a bunch of consumers willing to buy stuff, companies can respond in accord by supplying more goods. This will bring the price level back to equilibrium as the "bidding" war will be mitigated by goods flooding the marketplace. However, in cost-push inflation, during a "supply shock," the supply of goods is constriained and can't be increased immediately. When the good is a necessity, like oil, inflation is very hard to counter.

I hope this answered your question. This is a basic overview of what is taught in an intro to macro class. I've found this website to be VERY helpful when it comes to understanding basic economic metrics.

At 3/2/2013 12:42:13 PM, sadolite wrote:inflation occurs when the fed prints money with no wealth being created to justify it.

This is somewhat true. If aggregate demand and supply are fixed, more money in circulation generally results in higher inflation. But monetary policy is generally a response to changes in supply or demand (mainly demand). Since our recent recession was mostly caused by reduced demand, firing up the presses should not have drastically increased inflation. And it didn't.

At 3/2/2013 1:54:40 PM, Steelerman6794 wrote:Okay, I'll be the one to answer the question then.

The definition of inflation is simply an increase in the general price level, and therefore a fall in the purchasing power of money. If your tube of toothpaste previously cost $2 and now costs $5, each dollar now buys less of the same amount of toothpaste. Inflation occurs for a variety of reasons. Econ 101 focuses on a couple key models.

First, what you said about "too many dollars purchasing too few goods" is called demand-pull inflation. When the supply of good X stays the same, but suddenly a bunch more people decide to buy good X than usual, there will be a "bidding war" as people try to get their hands on X, and the price of X will increase. This can occur on a general scale as economies take off or the money supply increases. More people have more dollars to spend, so the price of goods are bidded up.

Another type of inflation is called "cost push inflation." This is when the demand for goods stays the same, but the supply DECREASES. In the 1970s during the Arab Oil Embargo, global oil supplies tightly contracted at the market. People still needed oil for there cars and homes, so there was a bidding war for what was left. The price of gasoline increased sharply as there simply wasn't enough to go around. Because oil is so fundamental to almost every product on the market, the general price level increased. Ergo, inflation.

Of these two types of inflation, demand-pull is generally considered "less bad." Why? Because when there are a bunch of consumers willing to buy stuff, companies can respond in accord by supplying more goods. This will bring the price level back to equilibrium as the "bidding" war will be mitigated by goods flooding the marketplace. However, in cost-push inflation, during a "supply shock," the supply of goods is constriained and can't be increased immediately. When the good is a necessity, like oil, inflation is very hard to counter.

I hope this answered your question. This is a basic overview of what is taught in an intro to macro class. I've found this website to be VERY helpful when it comes to understanding basic economic metrics.

So, inflation is not dependant on the money supply?In your examples, I would simply call that the effects of supply and demand. Which begs the question: is inflation simply the term used for the effects of supply and demand? If so, then the money supply is only a correlation to inflation, and not the cause, because the reason money supply would increase is because of a stonger economy (more people working means more money in circulation to pay them), which would allow for more demand for the yet to be adjusted supply.

But, why is money supply like QE3 supposed to lead to inflation? Or is that because of international markets' demand for the dollar going down? So, in a secluded nation, the money supply would have zero effect on prices, ergo inflation?

I understand supply and demand, but in your explanation, what is the supply and what is the demand? If money is the supply, is that not inflation, while demand for goods is constant. This sounds contradictory to the axiom: too many dollars chasing too few goods.

Are you saying that inflation is just the aggregate of supply and demand effects on prices? If so, why does money supply affect the price?

Demand is how much people are WILLING to pay for goods, not how much money is available.

The crux here is that the money supply affects demand, which in turn affects prices. If any increase in the money supply is stuffed in mattresses (e.g. the increase in demand = 0), prices wouldn't increase. This has actually been happening fairly recently. The Fed greatly expanded the money supply during the recession, but people were too scared to spend or invest, so demand didn't increase, and neither did inflation (or GDP, for that matter).

Understand that economic concepts can't really be explained in isolation. Everything is interdependent.....except when it's not. Isn't it great?

At 3/2/2013 1:54:40 PM, Steelerman6794 wrote:Okay, I'll be the one to answer the question then.

The definition of inflation is simply an increase in the general price level, and therefore a fall in the purchasing power of money. If your tube of toothpaste previously cost $2 and now costs $5, each dollar now buys less of the same amount of toothpaste. Inflation occurs for a variety of reasons. Econ 101 focuses on a couple key models.

First, what you said about "too many dollars purchasing too few goods" is called demand-pull inflation. When the supply of good X stays the same, but suddenly a bunch more people decide to buy good X than usual, there will be a "bidding war" as people try to get their hands on X, and the price of X will increase. This can occur on a general scale as economies take off or the money supply increases. More people have more dollars to spend, so the price of goods are bidded up.

Another type of inflation is called "cost push inflation." This is when the demand for goods stays the same, but the supply DECREASES. In the 1970s during the Arab Oil Embargo, global oil supplies tightly contracted at the market. People still needed oil for there cars and homes, so there was a bidding war for what was left. The price of gasoline increased sharply as there simply wasn't enough to go around. Because oil is so fundamental to almost every product on the market, the general price level increased. Ergo, inflation.

Of these two types of inflation, demand-pull is generally considered "less bad." Why? Because when there are a bunch of consumers willing to buy stuff, companies can respond in accord by supplying more goods. This will bring the price level back to equilibrium as the "bidding" war will be mitigated by goods flooding the marketplace. However, in cost-push inflation, during a "supply shock," the supply of goods is constriained and can't be increased immediately. When the good is a necessity, like oil, inflation is very hard to counter.

I hope this answered your question. This is a basic overview of what is taught in an intro to macro class. I've found this website to be VERY helpful when it comes to understanding basic economic metrics.

So, inflation is not dependant on the money supply?

Not inherently. That's why the money supply could increase in QE1 and QE2 without a lot of inflation.

In your examples, I would simply call that the effects of supply and demand. Which begs the question: is inflation simply the term used for the effects of supply and demand? If so, then the money supply is only a correlation to inflation, and not the cause, because the reason money supply would increase is because of a stonger economy (more people working means more money in circulation to pay them), which would allow for more demand for the yet to be adjusted supply.

You're on the right track. Economic growth ---> more money changing hands ---> increased amount of money in circulation. So yes, if the supply is fixed, and demand increases, the price level will increase = inflation. GDP will increase as well.

But, why is money supply like QE3 supposed to lead to inflation? Or is that because of international markets' demand for the dollar going down? So, in a secluded nation, the money supply would have zero effect on prices, ergo inflation?

The goal of QE3 is to get people to spend money. Flooding the economy with currency is more money for people to spend on goods and services. Ideally, this money would actually be spent, aggregate demand moves to the right, and GDP increases, along with a bit of an increase in the price level (ergo, inflation).

BUT, this is all dependent on people ACTUALLY spending the money. They haven't and are hoarding it instead, afraid to spend and invest. So there's a bunch of money sloshing around resulting in still low demand, low(ish) inflation, and low GDP.

An increase in the money supply, will, ceteris paribus, lead to an increase in general price levels. If the money supply was doubled over night, then prices would double. Of course, with the economy, everything is inter related, so an increase in the money supply will cause dislocations, for example inflation causes disincentives towards savings, and if there is less savings there is less investment and thus less capital, which will mean productivity is lower and therefor the general supply of goods will decrease... it's all very complicated

sometimes when people say 'inflation' they mean an increase in the money supply, other times they mean 'an increase in general price levels'. you can define the former as monetary inflation and the latter as price inflation.

At 3/2/2013 4:48:08 AM, Khaos_Mage wrote:The concept of inflation eludes me. I understand that it causes prices to rise, and is often said to be "too many dollars chasing too few goods". But I can't seem to wrap my head around it...

Could inflaction be represented by the following equations:Value of the dollar = money supply/ goods and servicesInflation = V$ in year X - V$ in year 0

Inflation is usually expressed as a rate. If you want to find the annual rate of inflation, then the equation should be

Inflation = ($$$ in year X) / [($$$ in year 0) * (# of years)]

If so, does this mean that if the money supply were to increase, inflation would go up, unless more goods and/or services were offered?

Yes.

Conversely, if more goods and services were offered, with no change in the money supply, there would be deflation?

And, in a recession, when goods and services go away due to businesses going under, this is why there is inflation.

Yes.

However, money printing is only one source of inflation.

Fractional-reserve banking is another source of inflation. Essentially, banks create money whenever they take a deposit, and then lend that deposited money back out. What this means is that credit expansion is a source of inflation, and credit contraction is a source of deflation.http://en.wikipedia.org...

Most recessions are accompanied by a large amount of credit contraction and are thus rather deflationary, despite there being fewer goods and services produced.

At 8/9/2013 9:41:24 AM, wrichcirw wrote:
If you are civil with me, I will be civil to you. If you decide to bring unreasonable animosity to bear in a reasonable discussion, then what would you expect other than to get flustered?

Is V another term for inflation, or referring to change in money supply? I assume the latter.

If I am right, it appears that inflation is simply a reactionary effect of other factors, and not its own event. (money supply, demand for goods are events which cause an effect) Or, perhaps a better description would be it is an aggregate effect of the change in factors, to be expressed as a simple figure.

While there is much dependancy between factors and their events, it seems inflation is only recationary, and never an event in of itself. If so, this explains its elusiveness to me and why there is no real formula for inflation, because it is just the rate of change between any factor of this formula from one year to the next.

I believe I understand.Thank you.

P.S. I am aware inflation does have an effect, but since it is a calculation of other events, inflation is not a "real" event, and simply measured for purposes of easy reference. I am merely trying to exagerate the difference so I can explain it quickly/specifically.

At 3/2/2013 4:48:08 AM, Khaos_Mage wrote:If so, does this mean that if the money supply were to increase, inflation would go up, unless more goods and/or services were offered?

There would be inflation. Without more information, we can't say whether the rate of inflation would go up (because the increase in the money supply this year may be less than the increase last year, and because anticipation of future changes in the money supply may be more important than what's actually going on now).

Conversely, if more goods and services were offered, with no change in the money supply, there would be deflation?

Okay, now ceteris is no longer paribus. (All other factors are no longer held constant.) Yes, stimulus spending tends to cause inflation. It pushes in that direction. But it's not the only vector in play. We don't notice much inflation right now, right? And we've been stimulating away.

So let's look at the reason for the stimulus. We had a housing crash. And a stock market crash. People got laid off. Banks quit lending. That's four reasons that the money supply was down. So, unless the stimulus dumps as much money into the supply as those four problems took out of it, you'd have to call the net effect deflationary. Except that goods and services are reduced too, so that complicates the equation.

And, in a recession, when goods and services go away due to businesses going under, this is why there is inflation.

I don't think we normally have inflation in a recession. If fact, I remember consternation in the 70s, because economists couldn't explain why we had both at once. Goods and services do shrink in a recession, but the money supply shrinks too.

Is V another term for inflation, or referring to change in money supply? I assume the latter.

If I am right, it appears that inflation is simply a reactionary effect of other factors, and not its own event. (money supply, demand for goods are events which cause an effect) Or, perhaps a better description would be it is an aggregate effect of the change in factors, to be expressed as a simple figure.

While there is much dependancy between factors and their events, it seems inflation is only recationary, and never an event in of itself. If so, this explains its elusiveness to me and why there is no real formula for inflation, because it is just the rate of change between any factor of this formula from one year to the next.

I believe I understand.Thank you.

P.S. I am aware inflation does have an effect, but since it is a calculation of other events, inflation is not a "real" event, and simply measured for purposes of easy reference. I am merely trying to exagerate the difference so I can explain it quickly/specifically.

velocity of money is how fast money is travelling from person to person. For example, if you take a bunch of money and bury it, the money has no velocity and wouldn't effect inflation. However, if the money goes to buy something like coffee, and then the workers there use the money to pay for college, and the college professors use that money to buy tickets for a play, and so forth, then the money has velocity because its being used to buy stuff. How fast the money is shifting hands between person to person to buy goods or investment is the measure of velocity.

Increasing the velocity of money without increasing the money supply can have two effects, or a combination of two effects, it can either lead to inflation or it can lead to more goods or services being produced.

Is V another term for inflation, or referring to change in money supply? I assume the latter.

If I am right, it appears that inflation is simply a reactionary effect of other factors, and not its own event. (money supply, demand for goods are events which cause an effect) Or, perhaps a better description would be it is an aggregate effect of the change in factors, to be expressed as a simple figure.

While there is much dependancy between factors and their events, it seems inflation is only recationary, and never an event in of itself. If so, this explains its elusiveness to me and why there is no real formula for inflation, because it is just the rate of change between any factor of this formula from one year to the next.

I believe I understand.Thank you.

P.S. I am aware inflation does have an effect, but since it is a calculation of other events, inflation is not a "real" event, and simply measured for purposes of easy reference. I am merely trying to exagerate the difference so I can explain it quickly/specifically.

velocity of money is how fast money is travelling from person to person. For example, if you take a bunch of money and bury it, the money has no velocity and wouldn't effect inflation. However, if the money goes to buy something like coffee, and then the workers there use the money to pay for college, and the college professors use that money to buy tickets for a play, and so forth, then the money has velocity because its being used to buy stuff. How fast the money is shifting hands between person to person to buy goods or investment is the measure of velocity.

Increasing the velocity of money without increasing the money supply can have two effects, or a combination of two effects, it can either lead to inflation or it can lead to more goods or services being produced.

velocity is linked to fractional reserve banking.

At 8/9/2013 9:41:24 AM, wrichcirw wrote:
If you are civil with me, I will be civil to you. If you decide to bring unreasonable animosity to bear in a reasonable discussion, then what would you expect other than to get flustered?

Is V another term for inflation, or referring to change in money supply? I assume the latter.

If I am right, it appears that inflation is simply a reactionary effect of other factors, and not its own event. (money supply, demand for goods are events which cause an effect) Or, perhaps a better description would be it is an aggregate effect of the change in factors, to be expressed as a simple figure.

While there is much dependancy between factors and their events, it seems inflation is only recationary, and never an event in of itself. If so, this explains its elusiveness to me and why there is no real formula for inflation, because it is just the rate of change between any factor of this formula from one year to the next.

I believe I understand.Thank you.

P.S. I am aware inflation does have an effect, but since it is a calculation of other events, inflation is not a "real" event, and simply measured for purposes of easy reference. I am merely trying to exagerate the difference so I can explain it quickly/specifically.

velocity of money is how fast money is travelling from person to person. For example, if you take a bunch of money and bury it, the money has no velocity and wouldn't effect inflation. However, if the money goes to buy something like coffee, and then the workers there use the money to pay for college, and the college professors use that money to buy tickets for a play, and so forth, then the money has velocity because its being used to buy stuff. How fast the money is shifting hands between person to person to buy goods or investment is the measure of velocity.

Increasing the velocity of money without increasing the money supply can have two effects, or a combination of two effects, it can either lead to inflation or it can lead to more goods or services being produced.

velocity is linked to fractional reserve banking.

Unless somehow you're measuring Money, as the monetary base, then fractional reserve banking increases the money supply, not the velocity of money.

Is V another term for inflation, or referring to change in money supply? I assume the latter.

If I am right, it appears that inflation is simply a reactionary effect of other factors, and not its own event. (money supply, demand for goods are events which cause an effect) Or, perhaps a better description would be it is an aggregate effect of the change in factors, to be expressed as a simple figure.

While there is much dependancy between factors and their events, it seems inflation is only recationary, and never an event in of itself. If so, this explains its elusiveness to me and why there is no real formula for inflation, because it is just the rate of change between any factor of this formula from one year to the next.

I believe I understand.Thank you.

P.S. I am aware inflation does have an effect, but since it is a calculation of other events, inflation is not a "real" event, and simply measured for purposes of easy reference. I am merely trying to exagerate the difference so I can explain it quickly/specifically.

velocity of money is how fast money is travelling from person to person. For example, if you take a bunch of money and bury it, the money has no velocity and wouldn't effect inflation. However, if the money goes to buy something like coffee, and then the workers there use the money to pay for college, and the college professors use that money to buy tickets for a play, and so forth, then the money has velocity because its being used to buy stuff. How fast the money is shifting hands between person to person to buy goods or investment is the measure of velocity.

Increasing the velocity of money without increasing the money supply can have two effects, or a combination of two effects, it can either lead to inflation or it can lead to more goods or services being produced.

velocity is linked to fractional reserve banking.

Unless somehow you're measuring Money, as the monetary base, then fractional reserve banking increases the money supply, not the velocity of money.

With more velocity, you get more transactions involving FRB, which increases the money supply.

M in your equation involves whatever the Fed printed, and not what is created via FRB. Otherwise, V would have nothing to do with inflation, but it obviously does.

At 8/9/2013 9:41:24 AM, wrichcirw wrote:
If you are civil with me, I will be civil to you. If you decide to bring unreasonable animosity to bear in a reasonable discussion, then what would you expect other than to get flustered?

Is V another term for inflation, or referring to change in money supply? I assume the latter.

If I am right, it appears that inflation is simply a reactionary effect of other factors, and not its own event. (money supply, demand for goods are events which cause an effect) Or, perhaps a better description would be it is an aggregate effect of the change in factors, to be expressed as a simple figure.

While there is much dependancy between factors and their events, it seems inflation is only recationary, and never an event in of itself. If so, this explains its elusiveness to me and why there is no real formula for inflation, because it is just the rate of change between any factor of this formula from one year to the next.

I believe I understand.Thank you.

P.S. I am aware inflation does have an effect, but since it is a calculation of other events, inflation is not a "real" event, and simply measured for purposes of easy reference. I am merely trying to exagerate the difference so I can explain it quickly/specifically.

velocity of money is how fast money is travelling from person to person. For example, if you take a bunch of money and bury it, the money has no velocity and wouldn't effect inflation. However, if the money goes to buy something like coffee, and then the workers there use the money to pay for college, and the college professors use that money to buy tickets for a play, and so forth, then the money has velocity because its being used to buy stuff. How fast the money is shifting hands between person to person to buy goods or investment is the measure of velocity.

Increasing the velocity of money without increasing the money supply can have two effects, or a combination of two effects, it can either lead to inflation or it can lead to more goods or services being produced.

velocity is linked to fractional reserve banking.

Unless somehow you're measuring Money, as the monetary base, then fractional reserve banking increases the money supply, not the velocity of money.

With more velocity, you get more transactions involving FRB, which increases the money supply.

If your money is in the bank, its not considered to have velocity if you're not using the monetary base to be the same as money.

M in your equation involves whatever the Fed printed, and not what is created via FRB. Otherwise, V would have nothing to do with inflation, but it obviously does.

There are multiple ways to measure money. Monetary base, M1, M2 and M3. These all depend on what constitutes money. Does it include checking accounts, savings accounts, CDs, and so forth?

With more velocity, you get more transactions involving FRB, which increases the money supply.

If your money is in the bank, its not considered to have velocity if you're not using the monetary base to be the same as money.

You don't understand how it works. With more velocity comes more more transactions, and more deposits, and more money creation.

M in your equation involves whatever the Fed printed, and not what is created via FRB. Otherwise, V would have nothing to do with inflation, but it obviously does.

There are multiple ways to measure money. Monetary base, M1, M2 and M3. These all depend on what constitutes money. Does it include checking accounts, savings accounts, CDs, and so forth?

Look up fractional reserve banking. You have a good grasp of economics, you should know about the money multiplier.

At 8/9/2013 9:41:24 AM, wrichcirw wrote:
If you are civil with me, I will be civil to you. If you decide to bring unreasonable animosity to bear in a reasonable discussion, then what would you expect other than to get flustered?

With more velocity, you get more transactions involving FRB, which increases the money supply.

If your money is in the bank, its not considered to have velocity if you're not using the monetary base to be the same as money.

You don't understand how it works. With more velocity comes more more transactions, and more deposits, and more money creation.

M in your equation involves whatever the Fed printed, and not what is created via FRB. Otherwise, V would have nothing to do with inflation, but it obviously does.

There are multiple ways to measure money. Monetary base, M1, M2 and M3. These all depend on what constitutes money. Does it include checking accounts, savings accounts, CDs, and so forth?

Look up fractional reserve banking. You have a good grasp of economics, you should know about the money multiplier.

I could be wrong on this, but I'm pretty certain the M in MV = PQ involves only M0.

At 8/9/2013 9:41:24 AM, wrichcirw wrote:
If you are civil with me, I will be civil to you. If you decide to bring unreasonable animosity to bear in a reasonable discussion, then what would you expect other than to get flustered?

With more velocity, you get more transactions involving FRB, which increases the money supply.

If your money is in the bank, its not considered to have velocity if you're not using the monetary base to be the same as money.

You don't understand how it works. With more velocity comes more more transactions, and more deposits, and more money creation.

M in your equation involves whatever the Fed printed, and not what is created via FRB. Otherwise, V would have nothing to do with inflation, but it obviously does.

There are multiple ways to measure money. Monetary base, M1, M2 and M3. These all depend on what constitutes money. Does it include checking accounts, savings accounts, CDs, and so forth?

Look up fractional reserve banking. You have a good grasp of economics, you should know about the money multiplier.

I could be wrong on this, but I'm pretty certain the M in MV = PQ involves only M0.

Otherwise, it would make no sense that V could possibly affect P or Q. V only has an impact if the transactions themselves somehow cause inflation. This describes exactly the money multiplier effect through FRB.

At 8/9/2013 9:41:24 AM, wrichcirw wrote:
If you are civil with me, I will be civil to you. If you decide to bring unreasonable animosity to bear in a reasonable discussion, then what would you expect other than to get flustered?